Russian economy: a turning point

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MOSCOW. (RIA Novosti's economic news analyst Nina Kulikova). -- According to the preliminary data of the Federal State Statistics Service (Rosstat), Russia's GDP grew by 6% last year.

The indicator for 2004 was 7.1%, and 7.3% for 2003. Although these figures are satisfactory, there seems to be a clear tendency toward a slowdown of economic growth in Russia. However, it is not yet clear whether this tendency will persist.

Russia has achieved a number of economic successes in recent years. Even though since the break-up of the Soviet Union it has had to abandon state-planned economy, create basic market institutions and survive the 1998 financial crisis, it was awarded the status of a country with a market economy by the European Union and the United States. The macroeconomic situation stabilized, creating the basis for renewed economic growth in Russia. In terms of annual GDP growth, Russia gradually surpassed the European Union and the United States.

Last year, the Central Bank gold and foreign currency reserves exceeded the state foreign debt and reached $182.2 billion as of January 1, 2006, placing Russia among the world's ten leaders for this indicator. The stabilization fund is constantly growing through a fast increase in budget revenues from the fuel and energy complex. It exceeded $44 billion as of January 1, 2006. The growing stabilization fund and gold and foreign exchange reserves serve to protect Russia from external shocks.

Recently, the Russian authorities have stepped up their efforts in trying to convince potential investors that the investment climate in Russia has changed for the better, and they seem to have succeeded to a certain extent. A recent report of the United Nations Conference on Trade and Development (UNCTAD) reads, in particular, that in 2005 the volume of foreign direct investment in the Russian economy has doubled to reach $26.1 billion, up from $12.5 billion in 2004. Thus Russia has become the largest recipient of foreign funds in East Europe and CIS countries, the report says. According to the preliminary data of the Central Bank for 2005, the inflow of private capital into the country exceeded its outflow for the first time in Russia's recent history.

Perhaps the investors have reacted positively to Russia's early repayment of over a third of its debt to the Paris Club, the discharge of all debt to the International Monetary Fund (IMF), and the adoption, at long last, of a law on the liberalization of the equity market of the Russian gas monopoly Gazprom. A consistent upgrading of Russia's credit rating has also played a positive role. In the past several years, Russia has been awarded high investment-grade ratings by all major international rating agencies, i.e., Moody's, Fitch and Standard & Poor's.

The Russian stock market also registered growth in 2005: the RTS index nearly doubled from 614 to 1,125 points surging to its new historical record. Russia is consolidating its positions on the global IPO market: the past year saw the largest number of Russian companies emerging on the international stock markets. In 2005, initial public offerings (IPOs) of domestic companies' shares helped them to attract around $6 billion, compared to about $700 million in 2004. A number of companies intend to follow suit this year, in particular state-owned Rosneft and Vneshtorgbank. This is a major factor for enhancing the country's financial stability.

Russians' living standards have been rising of late, especially in big cities. According to Rosstat's data, their real money incomes rose by 8.3% in 2005 (by yearend results) from the 2004 level.

On the other hand, the Russian economy still faces many problems. One should not forget that an extremely favorable situation on the world fuel and raw materials market has had a positive impact on economic development over recent years. Russia's oil and gas complex plays a tremendous role in providing state budget revenues and ensuring the nation's favorable balance of payments. And the bulk of direct foreign investments is, as before, funneled into the energy industry. According to Russia's Economic Development and Trade Ministry, high prices for fuel and energy and the possibility of quickly building up energy exports account for about half of the increase in Russian GDP in the past several years.

It has often been said that Russian industry is not diversified and competitive enough. But now it has become clear that the possibilities for economic growth based on high oil prices have been used up. A gradual slowing down of economic growth in Russia for a third year running, despite the continued colossal hikes in world oil prices, demonstrates this well enough. The Economic Development and Trade Ministry forecasts that unless the economy reduces its dependence on the export of fuel and raw materials in the near future, the Russian economy will not be able to sustain GDP growth at more than 4-5% even given high world oil prices.

The factors that slow down economic growth are the technological backwardness of the Russian economy and low innovation activity. Besides, the positive effects of the ruble's devaluation in 1998 are gradually wearing off, with competition on the internal markets increasing as a result. The possibilities of stimulating economic growth by reducing the tax burden further are, according to specialists, also close to running out. Small and medium-sized businesses are not developing sufficiently fast and cannot be the engine for the entire economy.

Also, according to Transparency International's annual corruption index, the graft rate in Russia rose in 2005. A year ago the country was placed 90th, while today it is 126th, ranking last among countries with an investment rating.

Finally, a fairly high rate of inflation - 10.9% in 2005 instead of the planned 8.5% - is a persistent headache for the authorities.

The Russian economy is therefore facing a crucial moment now when the authorities are actively seeking possible points of growth. According to Andrei Sharonov, Deputy Minister for Development and Trade, the current need is to promote institutional reforms, improve the quality of human capital and implement a system of strategic development projects with active organizational and financial backing of the state.

The government's position on economic growth is reflected in the Program for Social and Economic Development for 2005-2008. Its priorities include creating the conditions for improved quality of life through better health services, education, pension scheme, welfare, housing and municipal services, and control of poverty. So the four prime national projects - health care, education, housing and farming - announced by President Putin last fall may be seen as a fundamentally different and comprehensive approach to managing the nation's economy. But whether the allocated sum of 138 billion rubles (about $5 billion) will be sufficient for its implementation is another question.

The Program also focuses on providing better guarantees for property rights, including intellectual property, and development of competition. In addition, there have to be incentives for innovative economic development, enhancing the role of research and new ideas, and their contribution to economic diversification. As a separate issue, emphasis is put on making Russian companies more competitive, and developing small and medium-sized businesses, another factor in attracting investment and furthering economic modernization.

Work is well under way to set up an Investment Fund. Its purpose will be to support large-scale investment projects of national importance. The idea is to co-finance them together with the private sector and assign $2.5 billion in 2006 for this purpose.

Finally, new investment instruments are being introduced: special economic zones and public-private partnerships, which are expected to create mechanisms for drawing private investments into specific projects and help diversify the Russian economy and promote regional development.

To sum up, the measures announced by the Russian authorities to steer away from the model of development based on raw materials offer, in principle, feasible solutions to existing problems. And, combined, they may bring about favorable changes in the Russian economy. The only question is how well these measures will be translated into life.

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